States See Threat to Dual Banking System in Dodd Bill

WASHINGTON — State regulators are urging Senate Banking Committee Chairman Chris Dodd to change a provision in the regulatory reform bill that they claim would force most large state banks to convert to national charters.

Those conversions, in turn, would rob eight states of the funding necessary to police banks under their jurisdictions.

"A cascading effect will result as state banking departments lose their largest fee-providing banks and are forced to make up the difference by raising fees on the smaller banks, thus incentivizing even more charter flipping," said Richard Neiman, the New York State Superintendent of Banks.

Under the Dodd bill, all state-chartered banks, regardless of size, would be regulated by the Federal Deposit Insurance Corp. In most cases, their holding companies would be as well. The Federal Reserve Board would only regulate holding companies with more than $50 billion of assets and only 15 state-chartered banks belong to companies of that size.

What concerns Neiman and other state regulators is that 11 of those 15 banks would gain a third overseer. They would go from having two regulators under the current system (the Fed and the state) to three under the bill (the FDIC, the Fed and the state).

Those 11 state member banks hold a collective $1.13 trillion of assets and pay significant fees to eight states, including New York. Neiman said it is likely that those banks would convert to national charters so they would only have to answer to two agencies — the Office of the Comptroller of the Currency and the Fed.

"The Dodd bill at its core says it is supportive of the dual banking system and wants to maintain the dual banking system," Neiman said in an interview. But "transferring supervision from the Fed to the FDIC for state member banks has an anticipated significant impact on the dual banking system."

That added complication of an additional supervisor combined with a perception among some that the FDIC is not as experienced a regulator for the largest institutions would lead most or all of those banks to flip charters, Neiman said.

There would be "concern by the member banks as to the FDIC's level of current experience with respect to complex institutions of that size," Neiman said.

Ernest Patrikis, a lawyer at White & Case LLP who spent 30 years at the Federal Reserve Bank of New York, said Neiman's argument makes sense.

"Banks would no longer be supervised by the Fed who is familiar with their business, and then to be subject to three supervisors … they just might bite the bullet and convert to a national bank," he said.

State banks may also have an additional incentive to switch: higher exam fees.

Neither the FDIC nor the Fed currently charges banks for exams, letting state-chartered banks, which must only pay for their state supervision every other year, pay significantly less than nationally chartered institutions.

But the Dodd bill would require the Fed to charge holding companies for their supervision, ending that disparity and eliminating a key benefit of keeping the state charter.

More critically, however, is how much exam fees could rise for all state-chartered banks if large institutions do defect. The largest institutions represent a significant chunk of some states' assessment base, likely leading them to raise fees if there were conversions.

For example, if the top-three state member banks in New York — Bank of New York Mellon, Goldman Sachs Bank USA and M&T Bank — switched charters, New York would lose roughly 22% of its revenue from fees. Alabama could lose its two largest banks — Regions Bank and Compass Bank — representing 62% of its fees, while Ohio could lose Fifth Third Bank, representing 42% of its fees.

If affected states, which also include Georgia, Massachusetts, Illinois, Texas and Wisconsin, raised their exam rates, smaller institutions could also consider converting.

"For many states, the loss of the largest banks will result in significant declines in assessments, which would have to be passed on to the remaining state banks that are supervised by those states," Neiman said.

State regulators also argue they would lose a window into the largest banks.

The percentage of the nation's bank assets held by state banks would drop to roughly 20% from 30%, according to Neiman, if the Dodd bill leads these 11 banks to change their charters. That would continue a trend that has already been building for some time. Five years ago, state banks held 42% of the industry's total assets.

State bank officials argue the dual banking system would be weaker if it only supervised the smallest banks.

"It's quite possible that it's one of these tipping-point issues," said John Ryan, an executive vice president with the Conference of State Bank Supervisors, who has lobbied with Neiman on this issue.

The group is asking Congress to allow the Fed to keep supervision of all state member banks and bank holding companies. At a minimum, they want lawmakers to allow state member banks with more than $50 billion of assets to stay under the Fed's supervision, ensuring they do not face an additional regulator.

But some observers said they do not see many incentives for large banks to change charters.

Brad Sabel, a partner at Shearman & Sterling LLP and a former New York Fed official, said banks like Bank of New York or Goldman Sachs do not need a national charter because they have no plans to establish branches outside of New York.

"I don't think they see a need to have a national bank network," Sabel said.

Paul Miller, managing director of Friedman Billings Ramsey & Co., said exam fees are not a critical issue to many of the largest banks. "That's just a tax." he said. "I don't think that's going to kill anybody."

But Neiman and Ryan are hopeful their arguments are gaining traction with lawmakers. They have met with Dodd and Sen. Richard Shelby, the Banking Committee's lead Republican as well as officials at the Treasury Department, the Fed and other lawmakers. Ryan said most members of Congress have been unaware of the potential impact on the dual banking system.

"So much of this regulatory reform effort is about addressing issues around our largest, most-complex institutions, and as they address those, they are not always aware of the consequences for the rest of the system," Ryan said.

Some, however, said Congress may not care.

Dodd originally sought to reduce the number of regulators from four to one, before he backed off the idea.

Having a more minor role for the states may not bother many lawmakers, some said.